The UK oil and gas regime: an update on recent changes

Over two years have now passed since the publication of the Wood Review, which recommended reform of the UK oil and gas regime, aimed at Maximising Economic Recovery from the United Kingdom Continental Shelf (MER UK). In this briefing, we take a look at the status of implementation of those reforms by the UK Government, with a focus on recent developments, as well as what to look out for in the near-future.

What You Need to Know

• The new MER UK Strategy came into force on 18 March 2016 and applies to all existing and future licensees.
• The Oil and Gas Authority will become fully independent and have new powers once the Energy Bill 2015-16 comes into force.
• The 29th offshore licensing round will commence before the end of Q3 2016.
• A new "Innovate Licence" is being introduced for future licensing rounds.

The MER UK Strategy

One of the key recommendations of the Wood Review was that the Government and industry should develop and commit to a new strategy for MER UK.

The Infrastructure Act 2015 amended the Petroleum Act 1998 to include a new Part 1A, to provide for the development and implementation of the MER UK Strategy. In November 2015, the Department of Energy and Climate Change (DECC) published the draft Strategy for consultation. It was laid before Parliament for scrutiny on 28 January 2016 and came into force on 18 March 2016.

Scope and effect of the new Strategy

The Strategy is binding on the Secretary of State; the Oil and Gas Authority (OGA) (see below); holders of offshore petroleum licences; operators appointed under those licences; owners of upstream petroleum infrastructure (and, subject to the Energy Bill 2015-16, owners of relevant offshore installations); and persons planning and carrying out the commissioning of upstream petroleum infrastructure. The OGA will have power to enforce compliance with the Strategy. For the time being at least, the Strategy only applies to offshore oil and gas operations.

Key obligations arising under the Strategy

The Strategy is a succinct document. Its key elements are as follows:

• a Central Obligation stating that "Relevant persons must, in the exercise of their relevant functions, take the steps necessary to secure that the maximum value of economically recoverable petroleum is recovered from the strata beneath relevant UK waters". "Economically recoverable" is defined to mean "those resources which could be recovered at an expected (pre-tax) market value greater than the expected (pre-tax) resource cost of their extraction, where costs include both capital and operating costs but exclude sunk costs and costs (such as interest charges) which do not reflect current use of resources. In bringing costs and revenues to a common point for comparative purposes a ten per cent real discount rate will be used";
• a number of Supporting Obligations, including obligations to:
  • plan, fund and undertake exploration activities in a manner which is optimal for maximising the value of economically recoverable petroleum that can be recovered under the licence;
  • plan, commission and construct infrastructure in a way that meets the optimum configuration for maximising the value of economically recoverable petroleum that can be recovered from the region in which the infrastructure is to be located;
  • allow access to infrastructure and, significantly, where the infrastructure is not able to cope with demand for its use, prioritising access which maximises the value of economically recoverable petroleum; and
  • before planning the decommissioning of infrastructure, ensure that all viable options for its continued use have been suitably explored, including those which are not directly relevant to the recovery of petroleum such as the transport and storage of carbon dioxide;
• a number of Required Actions and Behaviours, including a requirement to comply with all obligations in a "timely fashion" and a requirement to consider whether collaboration or co-operation with others with interests in the region could reduce costs, increase recovery of economically recoverable petroleum or otherwise affect their compliance with the obligation in question; and
• a number of Safeguards for those complying with the Strategy – key among these is the principle that "no obligation imposed by or under this Strategy requires any person to make an investment or fund activity (including existing activities) where they will not make a satisfactory expected commercial return on that investment or activity". "Satisfactory expected commercial return" is defined to mean an expected post-tax return that is reasonable having regard to all the circumstances including the risk and nature of the investment (or other funding as the case may be) and the particular circumstances affecting the relevant person.

Sector strategies

The Wood Review also called for the development of a suite of six "sector strategies" covering the following areas:

• exploration;
• asset stewardship;
• regional development;
• infrastructure;
• technology; and
• decommissioning.

It is intended that the sector strategies will be developed in due course and will provide greater detail on the actions needed to deliver MER UK in each of these sectors. However, these strategies will not be legally binding in the same way as the MER UK Strategy. The decommissioning strategy is expected to be published by the end of the second quarter of 2016.

The Energy Bill 2015-16

The Energy Bill 2015-16 (Energy Bill), currently before Parliament, will allow the OGA to transition from its current status as an executive agency of DECC to a fully independent regulator, in the form of a State owned company. The Energy Bill will also give the OGA various new powers relating to access to meetings, data sharing, dispute resolution and imposition of sanctions.

When the Energy Bill was going through the Parliamentary process, the House of Lords sought to include in the Bill an amendment to the definition (set out in the Petroleum Act 1998) of the "Principal Objective" – that is, the MER UK principle. The amendment sought to re-formulate MER UK as "maximising the economic return of UK petroleum, while retaining oversight of the decommissioning of oil and gas infrastructure, and securing its re-use for transportation and storage of greenhouse gases". The amendment was rejected by the House of Commons on the basis that this would diminish the MER UK principle as formulated by the Wood Review, at a time when a renewed focus on revitalising the industry is badly needed. Instead, section 8 of the Bill, dealing with matters to which the OGA must have regard, has been amended to include a reference to "the development and use of facilities for the storage of carbon dioxide".

The Energy Bill is in its final stages of the Parliamentary process and is expected to receive Royal Assent by Summer 2016, although there is some concern that disagreement between the House of Commons and the House of Lords relating to some aspects of the Bill unrelated to oil and gas may delay the Bill.

29th offshore licensing round

The 29th offshore licensing round is likely to take place in the second or third quarter of 2016, subject to the successful completion of the Strategic Environmental Assessment. It is intended that it will focus on frontier areas, including the Rockall Basin, Mid-North Sea High Basin and East Shetland Platform. The 30th offshore licensing round will follow in 2017, and will focus on more mature areas.

The new "Innovate Licence"

In recent years, the Government introduced some variations on the traditional seaward production licence, to take account of the particular circumstances of a field. The two main variations have been the Promote Licence and the Frontier Licence. The OGA now intends to introduce a new variation – the Innovate Licence. The Innovate Licence will be partially implemented for the 29th offshore licensing round and fully implemented for the 30th offshore licensing round.

The key features of the Innovate Licence are as follows:

• an initial term of up to nine years and a second term of four to six years;
• three phases during the initial term:
  • phase A – for studies and reprocessing;
  • phase B – for shooting new seismic; and
  • phase C – for drilling wells;
• during the licence bidding process, bidders will be able to put forward their timeline for the initial term – that is, the length of each phase and which phases are required;
• the new licence will be available everywhere on UKCS, with larger tranches of acreage on offer;
• the financial capacity, plus technical, environmental and safety competence tests, will be deferred until phase C of the initial term; and
• greater flexibility in relation to relinquishment obligations.